Tax Credits for Working Families: The New American Social Policy

Executive Summary

In a policy environment averse to direct spending on programs dedicated to income support, a variety of federal tax credits have emerged as key vehicles for providing assistance to low-to-moderate income families. Indeed, the two largest individual income tax credits—the Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC)—will represent over $75 billion in tax expenditures in 2003.

Looking for ways to expand the constituency for tax credits to include more "working families" with low-to-middle incomes, this paper reviews the current regime of tax credits, their design, and the political dynamics behind their appeal and finds that:

  • Tax credits for working families have expanded rapidly in recent years. Voter attitudes, congressional partisanship, budgetary rules, and shifting viewpoints among public finance experts have all helped fuel a rise in tax expenditures. However, large tax cuts enacted in 2001 and 2003 will likely constrain near-term efforts at the federal level to expand income support for working families.

  • Tax expenditures are more significant for lower-income and higher-income families than for middle-income families. Lower-income families benefit from a number of income-targeted credits , while upper-income families benefit from deductions for mortgage interest and state and local taxes, as well as the exclusion of employer-paid benefits from income. Those families in the middle can be said to face a "middle-class parent penalty."

  • Tax credits designed to provide income security for working families have grown much larger than other types of credits. While the EITC and CTC combined provided over $75 billion to working families in 2003, tax credits tied to the consumption of particular goods and services totaled only $11.6 billion, and general business tax credits designed to benefit low-income workers and communities totaled only $5.4 billion.

  • A new income security tax credit or a combination of the existing EITC and CTC could broaden support for, and understanding of, federal investments in working families. Such a credit should be available to working families with up to $75,000 in adjusted gross income. A combined credit, seamless for taxpayers applying for it, would also reduce errors in the EITC program by reducing complexity.

Though some might argue that a combined tax credit could dilute support for separate existing programs, a streamlined credit for low-to-middle income working families seems one of the few politically viable ways to expand support for these families in a tight budget environment.